The View | Why China is unlikely to cut interest rates despite economic headwinds

Name: Mass Covid-19 testing under way across China amid rising infections fuelled by Delta variant
Uploaded: 2021-08-03T08:30:12.000Z
Duration: 3 min 18 s
Description: Mass Covid-19 testing under way across China amid rising infections fuelled by Delta variant

Monetary policy will probably ease to help small businesses and prevent an economic slump. But a rate cut is a significant and blanket move likely to feed inflation and the housing bubble

Reading Time:3 minutes

Why you can trust SCMP

A cleaner sweeps the ground in front of the People’s Bank of China headquarters in Beijing on May 19. There is little hope the authorities will allow a significant easing of the monetary policy to prevent a further slowdown in the economy. Photo: Bloomberg

Hao Zhou

Published: 4:30pm, 3 Aug 2021

With China’s economy losing steam since the second quarter of this year, there is market speculation that the central bank would cut the policy rate, i.e. the loan prime rate, soon. But the market is likely to be disappointed.

Certainly, there are increasing signs that the Chinese economy faces more headwinds in the second half of this year. For instance, the official manufacturing purchasing managers’ index for July came in at 50.4, well below market consensus.

Meantime, the Delta variant has been spreading rapidly across the country, and partial lockdowns have been imposed in a few cities, furthering weighing on the already struggling services sector.

03:18

Mass Covid-19 testing under way across China amid rising infections fuelled by Delta variant

The crackdown on the housing market and private tuition is also likely to dampen relevant economic activity. Conventional thinking is that China will start easing its monetary policy to hedge against the economic risks. From this perspective, a cut to the policy rates seems to make sense.

However, a rate cut is hardly on the table if we take a closer look at the policy dynamics. The meeting last week by the Politburo, China’s top policymaking body, suggests a largely unchanged monetary policy stance in the coming quarters. Its statement said that monetary policy should remain “prudent” and maintain “reasonably ample liquidity” – a repetition of the wording used at the Politburo’s previous economic meeting in April.

China watchers should know that this suggests the room for rate cuts is very limited for now.

The most significant constraint for the People’s Bank of China (PBOC) is the debt overhang. Over the past decade, China has conducted several rounds of financial deleveraging to prevent rapid debt accumulation.